Accounting scandal of 2001

Main article: Enron scandal

After a series of revelations involving irregular accounting procedures bordering on fraud perpetrated
throughout the 1990s involving Enron and its accounting firm Arthur Andersen, Enron stood on the verge of
undergoing the largest bankruptcy in history by mid-November 2001 (the largest Chapter 11 bankruptcy until
that of Worldcom in 2002, now surpassed by the collapse of Lehman Brothers). A white knight rescue attempt
by a similar, smaller energy company, Dynegy, was not viable.

As the scandal unraveled, Enron shares dropped from over US$90.00 to just pennies. Enron had been
considered a blue chip stock, so this was an unprecedented and disastrous event in the financial world. Enron's
plunge occurred after it was revealed that much of its profits and revenue were the result of deals with special
purpose entities (limited partnerships which it controlled). The result was that many of Enron's debts and the
losses that it suffered were not reported in its financial statements.

Enron filed for bankruptcy on December 2, 2001. In addition, the scandal caused the dissolution of Arthur
Andersen, which at the time was one of the world's top accounting firms. The firm was found guilty of
obstruction of justice in 2002 for destroying documents related to the Enron audit and was forced to stop
auditing public companies. Although the conviction was thrown out in 2005 by the Supreme Court, the
damage to the Andersen name has prevented it from returning as a viable business.

Enron also withdrew a naming rights deal with the Houston Astros Major League Baseball club to have its
name associated with their new stadium, which was formerly known as Enron Field (it is now Minute Maid
Park).

[edit] Accounting practices

Enron had created offshore entities, units which may be used for planning and avoidance of taxes, raising the
profitability of a business. This provided ownership and management with full freedom of currency movement
and the anonymity that allowed the company to hide losses. These entities made Enron look more profitable
than it actually was, and created a dangerous spiral in which each quarter, corporate officers would have to
perform more and more contorted financial deception to create the illusion of billions in profits while the
company was actually losing money. This practice drove up their stock price to new levels, at which point the
executives began to work on insider information and trade millions of dollars worth of Enron stock. The
executives and insiders at Enron knew about the offshore accounts that were hiding of losses for the company;
however the investors knew nothing of this. Chief Financial Officer Andrew Fastow led the team which created
the off-books companies, and manipulated the deals to provide himself, his family, and his friends with
hundreds of millions of dollars in guaranteed revenue, at the expense of the corporation for which he worked
and its stockholders.

In 1999, Enron launched EnronOnline, an Internet-based trading operation, which was used by virtually every
energy company in the United States. Enron president and chief operating officer Jeffrey Skilling began
advocating a novel idea: the company didn't really need any "assets." By pushing the company's aggressive
investment strategy, he helped make Enron the biggest wholesaler of gas and electricity, trading over $27
billion per quarter. The firm's figures, however, had to be accepted at face value. Under Skilling, Enron
adopted mark to market accounting, in which anticipated future profits from any deal were tabulated as if real
today. Thus, Enron could record gains from what over time might turn out losses, as the company's fiscal
health became secondary to manipulating its stock price on Wall Street during the Tech boom. But when a
company's success is measured by agreeable financial statements emerging from a black box, a term Skilling
himself admitted, actual balance sheets prove inconvenient. Indeed, Enron's unscrupulous actions were often
gambles to keep the deception going and so push up the stock price, which was posted daily in the company
elevator. An advancing number meant a continued infusion of investor capital on which debt-ridden Enron in
large part subsisted. Its fall would collapse the house of cards. Under pressure to maintain the illusion, Skilling
verbally attacked Wall Street Analyst Richard Grubman[6], who questioned Enron's unusual accounting practice
during a recorded conference call. When Grubman complained that Enron was the only company that could
not release a balance sheet along with its earnings statements, Skilling replied "Well, thank you very much, we
appreciate that . . . asshole." Though the comment was met with dismay and astonishment by press and
public, it became an inside joke among many Enron employees, mocking Grubman for his perceived meddling
rather than Skilling's lack of tact. When asked during his trial, Skilling wholeheartedly admitted that industrial
dominance and abuse was a global problem: "Oh yes, yes sure, it is."[1]

[edit] Peak and decline of stock price

In August 2000, Enron's stock price hit its highest value of $90.[7] At this point Enron executives, who possessed
the inside information on the hidden losses, began to sell their stock. At the same time, the general public and
Enron's investors were told to buy the stock. Executives told the investors that the stock would continue to
climb until it reached possibly the $130 to $140 range, while secretly unloading their shares.

As executives sold their shares, the price began to drop. Investors were told to continue buying stock or hold
steady if they already owned Enron because the stock price would rebound in the near future. Kenneth Lay's
strategy for responding to Enron's continuing problems was in his demeanor. As he did many times, Lay would
issue a statement or make an appearance to calm investors and assure them that Enron was headed in the
right direction.

By August 15, 2001, Enron's stock price had fallen to $42. Many of the investors still trusted Lay and believed
that Enron would rule the market. They continued to buy or hold their stock and lost more money every day.
As October closed, the stock had fallen to $15. Many saw this as a great opportunity to buy Enron stock
because of what Lay had been telling them in the media. Their trust and optimism proved to be greatly
misplaced.

Lay has been accused of selling over $70 million worth of stock at this time, which he used to repay cash
advances on lines of credit. He sold another $20 million worth of stock in the open market. Also, Lay's wife,
Linda, has been accused of selling 500,000 shares of Enron stock totaling $1.2 million on November 28, 2001.
The money earned from this sale did not go to the family but rather to charitable organizations, which had
already received pledges of contributions from the foundation. Records show that Mrs. Lay placed the sale
order sometime between 10:00 and 10:20 AM. News of Enron's problems, including the millions of dollars in
losses they had been hiding went public about 10:30 that morning, and the stock price soon fell to below one
dollar. Former Enron executive Paula Rieker has been charged with criminal insider trading. Rieker obtained
18,380 Enron shares for $15.51 a share. She sold that stock for $49.77 a share in July 2001, a week before the
public was told what she already knew about the $102 million loss.

[edit] Post-bankruptcy

Enron initially planned to retain its three domestic pipeline companies as well as most of its overseas assets.
However, before emerging from bankruptcy, Enron spun off its domestic pipeline companies as CrossCountry
Energy.

Enron sold its last business, Prisma Energy, in 2006, leaving it as an asset-less shell. In early 2007, it changed its
name to Enron Creditors Recovery Corporation. Its goal is to pay off the old Enron's remaining creditors and
wind up Enron's affairs.

Shortly after emerging from bankruptcy in November 2004, Enron's new board of directors sued 11 financial
institutions for helping Lay, Fastow, Skilling and others hide Enron's true financial condition. The proceedings
were dubbed the "megaclaims litigation." Among the defendants were Royal Bank of Scotland, Deutsche Bank
and Citigroup. As of 2008, Enron has settled with all of the institutions, ending with Citigroup. Enron was able
to obtain nearly $20 billion dollars to distribute to its creditors as a result of the megaclaims litigation.

[edit] California's deregulation and subsequent energy crisis

See also: California electricity crisis

In October 2000, Daniel Scotto, the top ranked utility analyst on Wall Street, suspended his ratings on all
energy companies conducting business in California because of the possibility that the companies would not
receive full and adequate compensation for the deferred energy accounts used as the cornerstone for the
California Deregulation Plan enacted in the late 1990s. Five months later, Pacific Gas & Electric (PG&E) was
forced into bankruptcy. Senator Phil Gramm, the second largest recipient of campaign contributions from
Enron, succeeded in legislating California's energy commodity trading deregulation. Despite warnings from
prominent consumer groups which stated that this law would give energy traders too much influence over
energy commodity prices, the legislation was passed in December 2000.

As Public Citizen reported, "Because of Enron’s new, unregulated power auction, the company’s 'Wholesale
Services' revenues quadrupled—from $12 billion in the first quarter of 2000 to $48.4 billion in the first quarter
of 2001."[8]

Before passage of the deregulation law, there had been only one Stage 3 rolling blackout declared. Following
passage, California had a total of 38 blackouts defined as Stage 3 rolling blackouts, until federal regulators
intervened in June 2001. These blackouts occurred mainly as a result of a poorly designed market system that
was manipulated by traders and marketers. Enron traders were revealed as intentionally encouraging the
removal of power from the market during California's energy crisis by encouraging suppliers to shut down
plants to perform unnecessary maintenance, as documented in recordings made at the time. [9][10] These acts
contributed to the need for rolling blackouts, which adversely affected many businesses dependent upon a
reliable supply of electricity, and inconvenienced a large number of retail consumers. This scattered supply
raised the price exponentially, and Enron traders were thus able to sell power at premium prices, sometimes
up to a factor of 20x its normal peak value.

Bibliography

 Robert Bryce, Pipe Dreams: Greed, Ego, and the Death of Enron (PublicAffairs, 2002) ISBN 1-58648-
138-X
 Lynn Brewer, Matthew Scott Hansen, House of Cards, Confessions of An Enron Executive
(Virtualbookworm.com Publishing, 2002) ISBN 1-58939-248-5 ISBN 1-58939-248-5
 Kurt Eichenwald, Conspiracy of Fools: A True Story (Broadway Books, 2005) ISBN 0-7679-1178-4
 Peter C. Fusaro, Ross M. Miller, What Went Wrong at Enron: Everyone's Guide to the Largest
Bankruptcy in U.S. History (Wiley, 2002), ISBN 0-471-26574-8
 Loren Fox, Enron: The Rise and Fall. (Hoboken, N.J.: Wiley, 2003)
 Judith Haney Enron's Bust: Was it the result of Over-Confidence or a Confidence Game? USNewsLink/
December 13, 2001
 Marc Hodak, The Enron Scandal, Organizational Behavior Research Center Papers (SSRN), June 4, 2007
 Bethany McLean, Peter Elkind, Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of
Enron (Portfolio, 2003) ISBN 1-59184-008-2
 Mimi Swartz, Sherron Watkins, Power Failure: The Inside Story of the Collapse of Enron (Doubleday,
2003) ISBN 0-385-50787-9
 Daniel Scotto "American Financial Analyst: The First Analyst to recommend the selling of Enron Stock"